How Long Will It Take Tesco to Recover?

LONDON -- Top U.K. supermarket Tesco (ISE: TSCO.L) shocked the market back in January with its first profit warning in 20 years. The FTSE 100 firm saw almost 5 billion pounds wiped off the value of its shares at a stroke.

Nine months on, and a disappointing set of interim results later -- a double-digit percentage fall in trading profit -- Tesco's shares languish at the same level they dived to immediately following the profit warning.

So, how long will it take Tesco to recover? Let's have a look at three other supermarkets that have issued profit warnings in the past 10 years.

Morrison's meal deal: four years of indigestionIn March 2004, Wm Morrison Supermarkets completed the 3.4 billion pound acquisition of rival chain Safeway. Within six months, it issued a profit warning for its fiscal year 2005 -- the chain's first profit warning in 37 years.

By June 2005, Morrison had issued no less than five profit warnings, extending the fallout from the acquisition into fiscal year 2006. As the table below shows, it would take until 2008 for Morrison's earnings per share to surpass its pre-profit-warning level of 2004.

2004

2005

2006

2007

2008

Revenue (in billions of pounds)

4.9

12.1

12.1

12.5

13.0

EPS (in pence)

12.6

8.1

(9.5)

9.3

20.8

Dividend per share (in pence)

3.3

3.7

3.7

4.0

4.8

Of course, Morrison's bout of severe indigestion from feasting on Safeway is very different to Tesco's current situation.

However, there are perhaps a couple of points worth noting. On the optimistic side, Morrison was able to maintain its dividend despite its difficulties. On the pessimistic side, analysts remained over-optimistic about Morrison's earnings, not only after the first profit warning but also through the following 12 months.

Sainsbury's six years of hurt

J Sainsbury issued three profit warnings for its fiscal year 2005. The company had been chasing higher margins at the expense of the customer experience. Sound familiar?

Sainsbury's directorspeak and actions to remedy the situation in 2004-05 also reverberate in many ways with Tesco's in 2012. Here are some pertinent snippets from Sainsbury:

There is nothing fundamentally wrong with the brand. The problem was that we hadn't delivered it well enough in recent years.

Our number one priority ... to make things better for our customers as quickly as possible ... to "fix the basics."

Recruitment of 3,000 additional colleagues into stores.

131 stores have not received any investment for a number of years ... Customers, representing 20 percent of Sainsbury's sales, are not experiencing the best store environment and these stores will be refurbished over the next two years.

Overall, we think we've made a good start, but there's still much left to be done.

As the table below shows, there was indeed much left to be done.

2004

2005

2006

2007

2008

2009

2010

Revenue (in billions of pounds)

18.2

16.6

16.1

17.2

17.8

18.9

20.0

EPS (in pence)

20.7

-3.0

3.8

19.2

19.1

16.6

32.1

Dividend per share (in pence)

15.7

7.8

8.0

9.8

12.0

13.2

14.2

Sainsbury had reckoned it would take until fiscal year 2008 to bring about lasting change. As far as earnings performance was concerned, it took until 2010 for EPS to surpass its pre-profit-warning level of 2004. Meanwhile, the dividend, which was slashed in 2005, had yet to regain its former level.

Carrefour on all fours: five years and countingFrench supermarket giant Carrefour has similar revenues to Tesco and, like its U.K. counterpart, is the dominant force in its home territory.

Carrefour issued a profit warning in June 2008 and a second six months later, citing weaker consumer spending, particularly in Europe. An uptick in revenues and earnings in 2010 proved to be a false dawn and the company issued five profit warnings for its fiscal year 2011.

As the table below shows, an improvement is expected in the current year. Nevertheless, the dividend has been cut, and both EPS and dividend per share are forecast to be at around half their pre-profit-warning level of 2007.

2007

2008

2009

2010

2011

2012 (forecast)

Revenue (in billions of euros)

82.1

87.0

87.4

91.5

80.5

80.8

EPS (c)

267

186

48

64

56

134

Dividend per share (c)

108

108

108

108

108

59

Foolish bottom lineIt took four years for Morrison to get its EPS back to the level before the first profit warning; it took Sainsbury six years; and for Carrefour it's five years and counting.

Tesco may pull a quick-turnaround rabbit out of the hat, but if recent supermarket history is any guide, it could be a longer and rougher ride than I suspect many investors are expecting.

Certainly, Tesco's problems amount to a whole lot more than one period of poor Christmas trading. In the words of the chief executive, the company needs to address "long-standing business issues" in the U.K.

Once on the wrong tack, supermarkets, like supertankers, typically take an age to change course. Tesco's shares may be trading at under 10 times current-year earnings forecasts and offer a prospective yield of 4.8%, but investors need to consider the opportunity cost of a protracted recovery.